The issues include a $4.6 million deficit in the city's self-funded health insurance plan in 2011-12, down from a $6.1 million shortfall the year before.

Vega said city and employee contributions have been increased to shore up the fund.

But Palacios said he would come to the council later this year with a proposal to end the 30-year self-funded plan and join a group insurance plan. He said all employee groups have agreed to make the change.

"It wasn't really working so we need to move to another model," Palacios said.

Water and sewer funds also ended the 2011-12 year in the red, but in June the City Council approved rate hikes that should close the deficit, Vega said.

On the plus side, the city's net assets grew from $250 million in 2010-11 to $269 million in 2011-12, Vega reported. And the city ended the fiscal year on June 30 with $24.1 million in cash on a budget of $100 million for all city funds.

The city's cash is distributed among various funds. The general fund, for examples, covers most spending for police, fire, parks and administration. Among the other funds are water and sewer, the airport, debt service, insurance and the library.

Though other cities in the region had stronger cash reserves, Vega said the amount was OK and would improve.

Revenue in Watsonville's general fund hit a high of $38.6 million in 2007-08, but dropped after that and was $33.2 million in 2011-12. An amount that is expected to stay stable in the current fiscal year.